Stakeholder Capitalism, Corporate Governance andFirm Value∗

Franklin AllenUniversity of Pennsylvania

Elena CarlettiCenter for Financial Studies

Robert MarquezArizona State University

August 4, 2007

Abstract

We consider the advantages and disadvantages of stakeholder-oriented firms that areconcerned with employees and suppliers as well as shareholders compared to shareholder-oriented firms. Societies with stakeholder-oriented firms have higher prices, lower out-put, and can have greater firm value than shareholder-oriented societies. In somecircumstances, firms may voluntarily choose to be stakeholder-oriented because thisincreases their value. Consumers that prefer to buy from stakeholder firms can alsoenforce a stakeholder society. With globalization entry by stakeholder firms is relativelymore attractive than entry by shareholder firms for all societies.

∗We are grateful to Giancarlo Spagnolo, Merih Sevilir, and Raghu Sundaram for their very helpfulcomments and suggestions and to seminar participants at HEC, the University of Frankfurt, Gothenberg,Mannheim, the Max Planck Institute in Bonn, and to participants at the UNC-Duke 2006 Corporate Fi-nance Conference, the 2006 Summer Research Conference at the Indian School of Business, and the 2007NBER/RFS Workshop. Franklin Allen is grateful to the Wharton Financial Institutions Center for financialsupport. Contact author: Franklin Allen, Wharton, School, University of Pennsylvania, 3620 Locust Walk,Philadelphia, PA 19104-6367, e-mail: allenf@wharton.upenn.edu.

Stakeholder Capitalism, Corporate Governance andFirm Value

Abstract

We consider the advantages and disadvantages of stakeholder-oriented firms that areconcerned with employees and suppliers in addition to shareholders compared to pureshareholder-oriented firms. Societies with stakeholder-oriented firms have higher prices,lower output, and can have greater firm value than shareholder-oriented societies. Insome circumstances, firms may voluntarily choose to be stakeholder-oriented becausethis increases their value. Consumers that prefer to buy from stakeholder firms canalso enforce a stakeholder society. With globalization entry by stakeholder firms isrelatively more attractive than entry by shareholder firms for all societies.

1 Introduction

In their classic survey of corporate governance, Shleifer and Vishny (1997; p. 738) outline

their focus in the following way: “Our perspective on corporate governance is a straightfor-

ward agency perspective, sometimes referred to as separation of ownership and control. We

want to know how investors get the managers to give them back their money.” In the US

and UK and many other Anglo-Saxon countries there is wide agreement that this is what

corporate governance is about. The law is clear that shareholders are the owners of the firm

and managers have a fiduciary (i.e., very strong) duty to act in their interests, and most of

the academic literature on governance has taken this perspective (see, e.g., Becht, Bolton,

and Roell, 2003, for a more recent survey).

However, moving beyond the cases of the US and UK, firms’ objectives depend very

much on the country being considered, and often deviate significantly from the paradigm

of shareholder value maximization. To provide one example, in Germany the legal system

is quite explicit that firms do not have a sole duty to pursue the interests of shareholders.

The Germans have the system of co-determination, in which employees and shareholders in

large corporations have an equal number of seats on the supervisory board of the company,

so that the interests of both must be taken into account (see Rieckers and Spindler, 2004,

and Schmidt, 2004).

Germany is by no means the only country where the interests of parties other than

just shareholders have bearing on companies’ policies, and we document differences across a

variety of countries in the next section. The common theme among these regimes, however,

can be seen from surveys of managers reported in Yoshimori (1995). Figure 1 shows the

choices of senior managers at a sample of major corporations in Japan, Germany, France,

the US, and the UK, between the following two alternatives:

(a) A company exists for the interest of all stakeholders (dark bar).

(b) Shareholder interest should be given the first priority (light bar).

In Japan the overwhelming response by 97% of those asked was that all stakeholders

1

were important. Only 3% thought shareholders’ interests should be put first. Germany and

France are more like Japan in that 83% and 78%, respectively, viewed the firm as being

for all stakeholders. At the other end of the spectrum, managers in the US and UK, by

majorities of 76% and 71% respectively, stated that shareholders’ interests should be given

priority.

The same survey also asked the managers what their priorities were with regard to

dividends and employee layoffs. They were asked to choose between the following specific

alternatives:

(a) Executives should maintain dividend payments, even if they must lay off a number

of employees (dark bar).

(b) Executives should maintain stable employment, even if they must reduce dividends

(light bar).

Figure 2 shows the results. There is again a sharp difference between Japan, Germany

and France and the US and UK, in that in the former countries it is stakeholders’ interests

more generally - and in particular workers - that must be considered by firms.

In this paper our aim is to develop a simple model of stakeholder governance in the

context of an imperfectly competitive product market where firms are concerned about their

continuity. We start by considering a two-period duopoly model of differentiated products

with price competition. In the first period firms are subject to a random shock to their costs

and if this shock is large enough they may be driven into bankruptcy. If both firms survive

they repeat the competition in the second period. If only one survives that firm becomes a

monopolist in the second period. In choosing their first period prices firms take into account

the effects on first period profits as well as on the probability of surviving into the second

period.

We model stakeholder governance as firms putting weight in their objective function on

the effects of bankruptcy on stakeholders other than shareholders. If firms do not survive,

stakeholders face costs of searching for new opportunities. If firms survive, stakeholders earn

2

rents from their relationships with firms. We show that when firms put weight on stakeholders

other than shareholders, this concern leads to a softening of competition: firms charge higher

prices and their probability of going bankrupt is reduced. Consequently, profits in the first

period as well as total firm value can be increased. Thus a concern for other stakeholders

can actually benefit shareholders through its effect on firm value. Of course, workers and

other suppliers are also better off from the softening of competition. However, since prices

are higher not everybody is better off and, in particular, consumers are worse off.

The fact that firm value can be increased by a concern for stakeholders raises the possibil-

ity that shareholders may actually want to put in place governance structures that commit

them to adopt a concern for other stakeholders. We show that, when firms anticipate a

sufficiently large reaction from their rivals, firms can improve their shareholders’ welfare by

voluntarily choosing to take into account other stakeholders. We also show that, even in

circumstances where firms may not voluntarily adopt a stakeholder orientation, such gover-

nance structures may nevertheless arise endogenously if consumers are more willing to buy

from firms that care about stakeholders other than shareholders.1 Interestingly, this leads

to a situation of self-enforcing societies where consumers induce firms to adopt stakeholder

concerns, and consequently increase the value to shareholders.

We extend our framework to analyze issues related to globalization, where it has become

commonplace for domestic firms to compete with firms from other countries. We show that

regardless of the governance structure domestically, incumbent firms fare better with the

entry of a stakeholder-oriented firm than with a shareholder-oriented firm. This suggests

that firms in countries that are stakeholder friendly have greater incentives to oppose the

entry of firms with shareholder-oriented governance structures than vice-versa. Similarly,

the desire for governments to protect domestic firms from foreign competition is likely to be

greatest for stakeholder economies facing potential entry by shareholder-oriented firms.

1An alternative could be that firms lobby to put in place government regulations requiring a morestakeholder-friendly approach to governance. Such political economy considerations may help explain thelegal requirements of codetermination in Germany, among other countries. See Pagano and Volpin (2005)for a broader discussion of the interaction between employment protection and the electoral system.

3

Our paper is related to a number of strands of literature. Blinder (1993) models the

objective function of Japanese firms as the weighted sum of shareholder profits and a function

of employee earnings. He shows this leads firms to maximize revenue. In contrast, we put

the firm-specific costs and benefits stakeholders receive in the objective function rather than

employee earnings. The stakeholders will earn their opportunity cost whether they have a

relationship with the firm or not. We show that concern for stakeholders leads to a concern

for survival and this softens competition.

Bris and Brisley (2005) show that having lower investor protection for minority share-

holders changes the way in which firms compete, leading to higher output and lower prices.

This makes consumers better off and can improve social welfare. Sklivas (1987) shows that

in oligopolistic industries shareholders can choose managerial incentives to alter the way in

which firms compete and shows that firm value can be increased in this way. Fershtman

and Judd (1987) also consider the interaction between managerial incentives and competi-

tion in oligopolistic markets. They show that compensation contracts can optimally depend

on things other than profits such as sales. There is a large literature on how debt affects

competition starting with Brander and Lewis (1986). They show that debt acts as a pre-

commitment device and changes the way in which firms compete (Allen, 2000, contains a

discussion of this literature). Our approach is similar in that stakeholder governance commits

the firms to be less aggressive, but we abstract from any additional strategic considerations

introduced by debt financing and instead assume the firm is purely equity financed.

Our focus is on the positive aspects of stakeholder governance, in particular on firm value

and prices. There is also the welfare issue of whether it is socially optimal for firms to pur-

sue shareholder interests as in the Anglo-Saxon countries or whether adopting a stakeholder

perspective can lead to a superior allocation of resources. We know from the fundamental

theorems of welfare economics that with perfect and complete markets, symmetric informa-

tion, and perfect competition the allocation is Pareto efficient if firms maximize the wealth of

shareholders. If any of these assumptions are violated then it is no longer clear that this ob-

4

jective leads to efficiency, and recent work by Allen and Gale (2000, Chapter 12) and Allen

(2005) argues that changing firms’ objective functions from just focusing on shareholder

wealth can correct for market failures. They give an example of an overlapping generations

model with young and old managers where requiring consensus as in Japanese firms (see

Aoki, 1990) can lead to a Pareto superior allocation.

Tirole (2001) takes a more negative view of the desirability of adopting a stakeholder-

oriented objective for the firm. He argues that there are no reliable measures of stakeholder

welfare, with no analogs to either accounting measures such as firm profits or market-based

measures such as a firm’s stock price. If workers and other stakeholders have interests that

diverge from those of shareholders, the lack of such measures makes it extremely difficult to

charge managers with anything other than the pure maximization of firm value.

However, in practice, firms in countries such as Germany where there is worker rep-

resentation on boards do pursue stakeholder interests. Our approach to modeling this is

that stakeholder firms will be more concerned about continuing in business than shareholder

firms. In models with perfect competition or monopoly, workers and shareholders will in

general have divergent interests. However, when firms compete strategically, shareholder

wealth is increased precisely through the commitment value of charging a manager to devi-

ate from pure value maximization. Along this dimension, therefore, shareholders’ incentives

are aligned with those of workers, and a commitment to a broader set of stakeholders can

still be consistent with the ultimate objective of increasing shareholder value.

There is a large managerial literature on how stakeholder governance can be imple-

mented. For example, Blair (1995) has suggested that firm-specific investments by employees

and other stakeholders are crucial. She argues that these people should be given residual

claimant status along with shareholders. O’Sullivan (2000) stresses the importance of build-

ing organizations that are able to continuously innovate and ensuring all stakeholders are

involved in this process.

The remainder of the paper proceeds as follows. In the next section we discuss how gov-

5

ernance arrangements vary across countries, and provide some institutional details. Section

3 presents a model analyzing the case where firms care about other stakeholders in addition

to shareholders. Section 4 focuses on the incentives of firms to become stakeholder oriented

and the possibility of having self-enforcing stakeholder economies. Section 5 looks at glob-

alization where different types of firms start competing with each other. Section 6 considers

the robustness of our results; and finally Section 7 concludes.

2 Governance Arrangements in Different Countries

As discussed above, the system of co-determination in Germany provides a clear example of

a country where firms’ objectives encompass a broader set of stakeholders in the firm than

merely those who own shares. However, Germany is by no means the only country with

such a system. Wymeersch (1998) documents several other countries that have some form

of co-determination. Austria has a system of co-determination similar to that in Germany.

The Netherlands has a system known as the structuurvennootschap that is applicable to all

larger companies except for those with an international group structure such as Royal Dutch

Shell and Unilever. Here the labor representation is indirect in that directors must have the

confidence of employees. Members of the supervisory board must take care of “the interest

of the company and its related enterprise” (Wymmeersch, 1998, p. 1144).

In Denmark, Sweden, and Luxembourg, there is employee representation on one-tier

boards. In Denmark, a third of the board is elected by employees (with a minimum of

two) in companies with more than 35 employees. In Sweden, companies with more than

25 employees must have two labor representatives appointed to the board, while companies

with more than 1,000 employees must have three. The rights and duties of these board

members are the same as all other board members. In Luxembourg, firms with more than

1,000 employees and some firms with a state connection have one third of the board elected

by the employees.

6

The system in France is different in that for firms with more than fifty workers two

workers’ representatives act as observers at board meetings. They do not have the right

to vote. More conventional co-determination systems exist for privatized public sector firms

and can be introduced voluntarily by firms. In Finland companies can also voluntarily adopt

employee representation on the board. More than 300 companies have reportedly done this

(Wymmeersch, 1998, p. 1141).

Another type of worker participation in decision making is on the “enterprise council.”

These are concerned with employment conditions such as lay-offs and plant closures. Com-

panies with at least 1,000 employees - of which there are 150 or more in two or more EU

countries - must have a “European Works Council.”

In Japan, the situation is yet again different from the US and UK. Managers do not have

a fiduciary responsibility to shareholders. The legal obligation of directors is such that they

may be liable for gross negligence in the performance of their duties, including the duty to

supervise (Scott, 1998). In practice, it is widely accepted that they pursue the interests of a

wide variety of stakeholders. This is well illustrated by a report of the annual meeting of the

International Corporate Governance Network in Tokyo from the Financial Times of August

1, 2001.

Hiroshi Okuda, chairman of Toyota Motor Corporation and of the Japan Fed-

eration of Employers’ Associations, told the assembled money managers that it

would be irresponsible to run Japanese companies primarily in the interests of

shareholders.

. . .Mr. Okuda made his point by telling guests what Japanese junior high school

textbooks say about corporate social responsibility. Under Japanese company

law, they explain, shareholders are the owners of the corporation. But if corpo-

rations are run exclusively in the interests of shareholders, the business will be

driven to pursue short-term profit at the expense of employment and spending

on research and development.

7

To be sustainable, children are told, corporations must nurture relationships with

stakeholders such as suppliers, employees and the local community. So whatever

the legal position, the textbooks declare, the corporation does not belong to its

owners.

. . . ‘In Japan’s case,’ said Mr. Okuda, ‘it is not enough to serve shareholders.’

It is readily seen that, while the specifics of the systems of governance in each country vary

widely, they have as a common objective the inclusion of parties beyond shareholders into

firms’ decision-making processes. In particular, in many countries workers play a prominent

role, being regarded as important stakeholders in the firm. The analysis that follows focuses

on this aspect of what we term “stakeholder governance.”

3 A Model of Stakeholder Governance

Consider first a simple one-period model where two firms, i ∈ A,B, offer differentiated

products and compete in prices. Each firm i faces a demand curve given by

Di = A− biipi + bijpj

for j 6= i, where pi and pj are the prices charged by firm i and j respectively, and bii and bij

depend on consumers’ preferences over the good sold by firm i relative to that sold by firm

j. We assume throughout that bii ≥ bij, so that firm i’s demand is at least as sensitive to

its own price as it is to the price charged by its competitor. Each firm i chooses its price to

maximize profit as given by

maxpi

πi = maxpi

(pi − c)Di(pi) = maxpi

(pi − c) (A− biipi + bijpj) ,

where the parameter c represents the marginal cost of producing one unit of output. We

assume that c is the same for both firms. The first order condition for profit maximization

8

gives

(A− biipi + bijpj)− (pi − c)bii = 0, (1)

which yields

pi =A + bijpj + cbii

2bii

.

Given a similar expression for firm j, we can solve for the equilibrium prices pi to obtain:

pi =1

bii

(A +

2

3cbii +

1

3cbij

).

We now introduce bankruptcy by adding a second period, identical to the first. However,

we also assume that firm i is subject to a shock to its marginal costs in period 1, so that

ci = c+εi, where εi is distributed according to the distribution function F (.). For tractability,

we assume that F is a symmetric distribution whose density function f is non-increasing in

the absolute value of the shock.2 Firm i can operate in period 2 only if its profit in the first

period, πi1, is nonnegative or, equivalently, if the shock is not too large: πi1 ≥ 0 ⇔ εi ≤ pi1−c.

Denoting by πM2 the profit that either firm earns if it is the sole surviving firm in period 2,

so that it is a monopolist, and by πD2 the profit obtained by each firm if both firms are still

active, firm i’s maximization problem becomes

maxpi1

Πi = E[πi1] + Pr(εi ≤ pi1 − c)[(1− Pr(εj ≤ pj1 − c)) πM

2 + Pr(εj ≤ pj1 − c)πD2

].

The first term represents the expected profit in the first period, while the second term is the

profit firm i obtains in the second period, which can be either πM2 when it is the only firm

surviving, or πD2 if both firms are still active. Each term is multiplied by the probability

the competing firm survives or not. The firm can also fail, in which case it gets zero profits.

2Any symmetric bell-shaped distribution satisfies this condition, as well as a uniform distribution over abounded support.

9

Noting that Pr(εi ≤ pi1 − c) = F (pi1 − c), the maximization problem can be written as

maxpi1

Πi = E[πi1] + F (pi1 − c)[(1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

].

We assume throughout that ∂2Πi

∂pj1∂pi1≥ 0, so that prices are strategic complements. This

condition can be expressed as

∂2i Πi

∂pj1∂pi1

=∂2E[πi1]

∂pi1∂pj1

− f(pi1 − c)f(pj1 − c)(πM

2 − πD2

) ≥ 0.

Note that ∂2E[πi1]∂pi1∂pj1

= bij > 0. The second term, however, is negative because the incentive

for firm i to survive when firm j does not survive introduces an element of strategic sub-

stitutability into the model. The condition therefore amounts to assuming that the effect

on first period profits of an increase in a competitor’s price is greater than the reduction in

second period profit when the competitor also survives.

We also assume the standard regularity condition (see Dixit, 1986) that

∣∣∣∣∣∂2Πi

∂pj1∂pi1

∂2Πi∂p2

i1

∣∣∣∣∣ < 1,

which can be expressed as

∣∣∣∣∣∂2Πi

∂pj1∂pi1

∂2Πi

∂p2i1

∣∣∣∣∣ =

∣∣∣∣∣bij − f(pi1 − c)f(pj1 − c)

(πM

2 − πD2

)

bii + ∂f(pi1−c)∂pi1

((1− F (pj1 − c)) πM2 + F (pj1 − c)πD

2 )

∣∣∣∣∣ < 1 (2)

This condition implies well-behaved reaction functions for both firms.

Letting pi1 denote the equilibrium price for firm i in the first period, we have the following

immediate result.

Proposition 1 The concern for survival into the second period leads to higher first period

prices than in the one-period model, i.e., pi1 > pi.

Proof: Differentiating firm i’s expected profit with respect to pi1, we have

∂Πi

∂pi1

=∂E[πi1]

∂pi1

+ f(pi1 − c)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)= 0. (3)

10

Since f(pi1 − c) and((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)are both positive, and ∂2E[πi1]

∂p2i1

=

−2bii < 0, the equilibrium price is higher than in the one-period case, as given by (1). The

proposition follows. ¤

The intuition behind Proposition 1 is simple. The probability that a firm survives until

period 2, Pr(εi ≤ pi1 − c), is increasing in the first-period price pi1. Thus, the concern for

survival softens competition and induces firms to charge higher prices than in the one-period

model. As a consequence, each firm also produces less output. Whether or not this brings

the firms closer to the monopoly price, pMi , depends on how strong the firms’ incentives to

survive until period 2 are. Denoting by σi the variance of the shock εi to firm i’s marginal

costs, we can state the following:

Corollary 1 There exists a value of the shock variance, 0 < σi ≤ ∞, such that firms’ first

period equilibrium prices are lower than the price charged by a single-period monopolist firm:

pi1 < pMi for σi < σi.

Proof: See appendix. ¤

When firms care about surviving until period 2, they set prices to maximize their expected

profits across both periods. This means firms balance out the maximization of first period

profits with minimizing the possibility of bankruptcy and thus increasing their chances of

survival. When survival is very uncertain because marginal costs are highly volatile, firms

set higher prices to guarantee survival, potentially setting a price in the first period much

higher than the monopoly price. If the price chosen is too high, output can be reduced to

such an extent that profits are lower in the first period. When survival is not as uncertain,

firms set prices below the level chosen by a monopolist and they have higher first-period

profits relative to the case when they care only about the single period. In what follows, we

assume throughout that σi < σi.

We have assumed so far that firms maximize their expected profits, taking into account

only shareholder value. We now introduce a concern for other stakeholders. If a firm were

11

to go bankrupt, its employees and suppliers would have to bear the costs of finding new jobs

and customers. If the firm is interested in stakeholders other than shareholders it will attach

some weight to these costs in its objective function. This modifies the objective function for

firm i as follows:

maxpi1

Ωi = Πi − (1− F (pi1 − c)) Ki (4)

= E[πi1] + F (pi1 − c)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)− (1− F (pi1 − c)) Ki,

where for simplicity of notation, Ki combines the weighting the firm puts on stakeholder

costs and the level of these costs.3 In addition to the costs stakeholders incur in bankruptcy,

they may also earn rents when the firm stays solvent. We could represent the weight the

firm puts on these benefits to stakeholders by an additional positive term ki in the objective

function, received only if the firm survives across periods (i.e., with probability F (pi1 − c)).

As we shall see in Section 6 below, such a term has a similar effect to that studied here. For

the moment we therefore focus on the formulation in (4).

An important issue concerns the way in which (4) is implemented. As discussed in

the introduction, in Germany codetermination requires that in large firms workers have

representation on the supervisory board. This ensures that the organizational structure of

decision making is such that workers’ representatives have an important say in the strategic

direction of the company. The objective function (4) is one way of capturing this. However,

codetermination is not the only way to build concern for stakeholders into the organizational

structure of the firm. The French requirement that workers’ representatives be able to attend

board meetings can change the way meetings are conducted. By requiring consensus in

decision making processes as in Japan (see Aoki, 1990) it may be possible to have the firm

put a weight on employees’ interests directly. Another way is to give managers a certain

3This specification also corresponds to the case where firms explicitly internalize the negative externalitytheir failure imposes on other parties who depend on the firm, such as employees. See Tirole (2006) for arecent discussion of stakeholder governance along these lines.

12

degree of freedom in decision making. Since managers’ interests are aligned in many ways

with those of other employees and stakeholders in terms of the costs they incur if the firm

goes bankrupt, this may be an effective way of implementing (4). O’Sullivan (2000) contains

a discussion of how organizational structure can be designed to alter decision-making within

the firm.

With (4) as the objective function for firms we have the following result.

Proposition 2 A concern for stakeholders leads firms to set higher prices, i.e., ∂bpi1(Ki)∂Ki

> 0.

Proof: Differentiating (4) with respect to pi1, we have

∂E[πi1]

∂pi1

+ f(pi1 − c)(Ki + (1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)= 0. (5)

Since the second term, f(pi1− c)(Ki + (1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

), is positive and

increasing in Ki, the equilibrium price must be increasing in Ki (Milgrom and Roberts, 1990,

1994). ¤

Proposition 2 establishes that a concern for stakeholders serves to soften competition

by increasing prices and reducing quantity in the first period. An interesting implication

of this concern for stakeholders is that firms’ production in stakeholder societies is further

away from the efficiency benchmark provided by the perfect competition paradigm. In other

words, the reduction in competition induced by firms’ concern for survival (Ki) leads to

greater markups over marginal cost, and thus lower output.

Whether or not firms themselves benefit depends on the magnitude of their concern for

employees.

Corollary 2 There exists a value Ki such that, for Ki < K i, firms have higher first-period

expected profits when they care about stakeholders than when they maximize only shareholder

value, i.e., E[πi1]|Ki>0 > E[πi1]|Ki=0 for Ki < Ki and E[πi1]|Ki>0 < E[πi1]|Ki=0 otherwise.

13

Proof: See appendix. ¤

The result in Corollary 2 shows that firms may have higher expected profits in the first

period when they care about stakeholders. This occurs when the penalty Ki is not too high.

When Ki is very large, the concern for stakeholders induces firms to increase prices so much

that their sales, and consequently their profits, are hurt.

The corollary also gives rise to a result concerning the firm’s overall market value. Since,

for Ki < Ki firm i’s profits are higher in the first period, and since its probability of surviving

into the second period is increased for any positive value of Ki, it is possible that for Ki < Ki

firm i’s overall market value is increasing in Ki. The increase in the probability of surviving

is good in terms of the increase in profits obtained as a duopolist but may be bad in terms

of the reduction in profits as a monopolist because also firm j has a higher probability of

survival. We summarize this in the following corollary.

Corollary 3 For Ki = K < K, in a symmetric equilibrium firms will have higher overall

market value when they care about stakeholders than when they maximize only shareholder

value, i.e., Πi|K>0 > Πi|K=0 for K < K, if

(1− 2F )πM2 + 2FπD

2 > 0.

Proof: When the equilibrium is symmetric, Ki = Kj = K and pi1 = pj1, which implies that

F (pi1 − c) = F (pj1 − c) = F . Profits can then be written as

Πi = E[πi1] + F (1− F ) πM2 + F 2πD

2

The previous corollary establishes that F is increased by an increase in K. The derivative of

profits with respect to F :

∂Πi

∂F= (1− 2F )πM

2 + 2FπD2 .

This gives the condition above. ¤

14

While clearly F (.) depends on pi1 and is therefore endogenous, the condition can never-

theless be satisfied if πM2 = πD

2 . It will not be satisfied if πM2 is sufficiently large relative to πD

2 .

The result thus illustrates that shareholders and stakeholders interests are not necessarily

opposed but rather can be aligned since the increase in profits benefits the shareholders and

the increase in the probability of survival benefits its other stakeholders.

One final important point to notice is that even if having firms caring about stakeholders

can be beneficial for both shareholders and other stakeholders, it may not enhance total

welfare. The reason is that consumers are worse off due to the higher prices stakeholder

firms charge and the consequent reduction in output.

4 Self-enforcing Stakeholder Societies

So far we have analyzed the effect of a concern for stakeholders on firms’ equilibrium prices,

quantities, and profits. In doing this we have exogenously specified firms’ objective functions,

taking as given that firms care about stakeholders, either from convention or because of legal

requirements such as codetermination. We now analyze whether adopting such a concern

for employees and suppliers into the firm’s objective function would indeed arise as an equi-

librium result. That is, we endogenize the choice of Ki and consider whether firms find it

optimal to adopt organizational structures that put weight on stakeholders and thus pre-

commit to act like a stakeholder firm. While incorporating Ki into firms’ objective functions

clearly softens competition and may increase profits, it may not be an equilibrium for firms

to do this. The reason is that, when firm j cares about its stakeholders, it raises its price and

lowers its output. Firm i in that case may have an incentive to commit to being aggressive

by lowering its own price to capture a greater market share, which it achieves by choosing

an appropriate organizational structure that commits it not to care about stakeholders.

We analyze here two cases. First, we study whether, absent any other consideration, a

firm would naturally choose to assign some positive weight to its general stakeholders in its

15

objective functions. Second, we consider how consumers’ desires to transact with “socially

conscious” firms can alter the incentives for firms to become stakeholder oriented.

4.1 Firms’ Optimal Objective Functions

We extend here the model to introduce a first stage where we allow firms to choose Ki.

Assume that at time t = 0, each firm chooses the weight Ki that it places on stakeholder

concerns as part of its objective function. Then, conditional on each firm’s date 0 choice of

Ki, at time t = 1 each firm chooses a price to charge in the first period.

In order to precommit to the objective function chosen at the initial stage, firms must

implement an appropriate decision making structure within the firm. As discussed above,

putting workers’ representatives on the board is one extreme way of doing this. Requiring

consensus or allowing managers more autonomy are other ways to precommit to pursue

broader objectives.

Solving the two-stage game by backward induction, for given Ki and Kj, firm i’s optimal

price at t = 1 is given by pi1 (Ki, Kj), exactly as found in the previous section. At t = 0,

each firm then maximizes the objective function reflecting the market value of the firm with

respect to Ki, after substituting in the equilibrium prices pi1 (Ki, Kj), pj1 (Kj, Ki). For firm

i, the objective is:

maxKi

Πi = E[πi1(pi1, pj1)] + F (pi1 − c)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

),

where Πi = Πi(pi1 (Ki, Kj) , pj1 (Ki, Kj)).4 In what follows, we focus on the symmetric case

where bii = bjj and bij = bji, and on the symmetric equilibrium in the choice of Ki.

Proposition 3 Both firms voluntarily adopt a stakeholder approach to governance when the

4We assume throughout this section that, while the firm may implement a decision-making structure thatexplicitly incorporates a concern for workers, it still has as its objective the ex ante maximization of profits.An alternative specification would be that firms commit to bearing the costs of the externality their failureimposes on other stakeholders, as discussed in Tirole (2006). This could be formalized by assuming that thefirm bears a cost of Ki in case of failure as specified in equation (4), which would be subtracted from theobjective function above. All results go through under this alternative specification.

16

resulting marginal increase in expected profits is positive, i.e., Ki > 0 for ∂Πi

∂Ki

∣∣∣Ki=0Kj=0

> 0.

Proof: In a symmetric equilibrium, firms will choose a positive level of Ki if the marginal

effect of an increase in Ki on the overall profit, evaluated at Ki = Kj = 0, is positive. This

derivative can be obtained by the envelope theorem as

∂Πi

∂Ki

=∂E[πi1(pi1, pj1)]

∂pj1

∂pj1

∂Ki

− F (pi1 − c)

((πM

2 − πD2

)f(pj1 − c)

∂pj1

∂Ki

)− f(pi1 − c)Ki

∂pi1

∂Ki

,

(6)

which we require to be positive when evaluated at Ki = Kj = 0.

The term∂bpj1

∂Kican be written as

∂bpj1

∂Ki=

∂bpj1

∂bpi1

∂bpi1

∂Ki> 0, since

∂bpj1

∂bpi1> 0 given prices are

strategic complements and ∂bpi1

∂Ki> 0 from Proposition 2. The term

∂E[πi1(bpi1,bpj1)]

∂bpj1is clearly

positive. The last term is just zero for Ki = 0. Thus, the first term in (6) is positive while

the second is negative so that if∂E[πi1(bpi1,bpj1)]

∂bpj1is sufficiently large, a positive level of Ki will

be optimal. ¤

This result establishes that firms find it optimal to design organizational structures that

put weight on stakeholders in the decisionmaking process when the strategic response of

their competitors is sufficiently beneficial. To understand this better, recall that an increase

in Ki makes firm i less aggressive and raises firm i’s price. This, however, also causes firm

j to raise its own price. The net effect for firm i of firm j’s price increase is ambiguous

since it increases the likelihood that firm j will also survive into the second period, thus

reducing the chance that firm i earns monopolistic profits. Thus, only when firm j’s price

increase has a sufficiently large effect on firm i’s first period profits to compensate firm i for

its reduced chance of being a monopolist will firm i have an incentive to adopt a stakeholder

concern by setting Ki > 0. By contrast, when this effect is smaller, firms do not choose to

care about stakeholders in equilibrium, despite the fact that doing so would allow them to

soften competition. It bears noting, therefore, that absent other constraints on firm behavior,

there is no guarantee that firms will choose to be concerned about stakeholders even if such

a concern would raise each firm’s price and profit.

17

Firms’ incentives to adopt a stakeholder approach to governance depend on the degree

of competition in the first period as expressed by the size of the parameters bii and bij

representing the sensitivity of the demand of firm i to its own price and the price charged

by firm j. They also depend on the incentives to survive until period 2 as captured by the

probability of survival F (pi1 − c) and the profits πM2 or πD

2 obtained. Note that there is

always a value of δ > 0 such that, for πM2 − πD

2 ≤ δ, Proposition 3 will be satisfied. To show

that there are other cases where the condition in Proposition 3 is satisfied and firms adopt

a concern for stakeholders, we provide an example. In particular, we assume that the shock

εi is distributed according to a uniform distribution on [−1/2, +1/2] so that f(pi1 − c) = 1.

For simplicity, we also assume that consumers have the same sensitivity to changes in the

price of goods sold by firms i and j so that bii = bjj = bij = bji = b. In this case Proposition

3 is satisfied when

b > (πM2 − πD

2 )A + πM

2

A + πD2

.

Clearly, this is always satisfied when firms do not benefit from being monopolists in period

2 so that πM2 = πD

2 . Note also that in this example strategic complementarity requires

b > (πM2 − πD

2 ).

This is a weaker condition sinceA+πM

2

A+πD2

> 1.

4.2 Social Norms in Stakeholder Societies

When the conditions of Proposition 3 are not satisfied, it is not worthwhile for firms to choose

to adopt a concern for stakeholders because of the direct effects on strategic interaction. Even

when this is the case, however, there may be “social norms” or “social concerns” that induce

firms to become more stakeholder-oriented. To study this issue further and to capture one

aspect of what may be meant by a “stakeholder society,” we here suppose that customers

care directly about firms’ social concerns, and have a preference for buying from such firms.

18

Specifically, assume that customers prefer to purchase from firms that commit to care not

only about shareholder value, but also about their other stakeholders. This implies that if

firm i cares relatively more about its employees and other stakeholders than firm j, then

its demand will be less sensitive to changes in its own price: if firm i’s demand in the first

period is

Di1 = A− biipi1 + bijpj1,

then bii < bjj whenever Ki > Kj.

One simple way of incorporating this kind of preference by customers is to assume that

bii = G(Ki, Kj), with ∂G∂Ki

< 0 and ∂G∂Kj

> 0. This means that firm i’s demand becomes less

sensitive to pi1 as firm i increases its concern for stakeholders, and more sensitive to pi1 as

firm j increases such concern. Note that we make no assumption on whether overall demand

will increase, but rather only that the share of the market that any given firm can obtain

by incorporating Ki into its objective function may vary. Indeed, it could well be that if

both firms care about stakeholders equally, then there is no effect on the demand they face.

Formally, this can be implemented by assuming that G(Ki, Kj) = G whenever Ki = Kj.

With this in mind, we can now solve the same maximization problem as before with

respect to Ki as follows:

maxKi

Πi = E[πi1(pi1, pj1; Ki)] + F (pi1 − c)((1− F (pj1 − c))πM2 + F (pj1 − c)πD

2 ),

where again Πi = Πi(pi1, pj1). We now obtain the following.

Proposition 4 When customers’ demand is sufficiently responsive to firms’ concern for

stakeholders, firms always choose to adopt a stakeholder approach to governance, i.e., for∣∣∣ ∂G∂Ki

∣∣∣ sufficiently large, K∗i > 0. Moreover, K∗

i is increasing in∣∣∣ ∂G∂Ki

∣∣∣.

Proof: The derivative of the firm’s profit, Πi, with respect to Ki, is given by

∂E[πi1(.)]

∂Ki

+∂E[πi1(.)]

∂pj1

∂pj1

∂Ki

−F (pi1−c)

((πM

2 − πD2

)f(pj1 − c)

∂pj1

∂Ki

)−f(pi1−c)Ki

∂pi1

∂Ki

. (7)

19

Note that there is an additional leading term relative to the case where bii is constant, as

given by (6). This term is the direct effect of an increase in Ki on first period expected profits,

∂E[πi1(pi1, pj1; Ki)]/∂Ki. This term is positive, as it represents the fact that, holding price

constant, an increase in Ki decreases bii, and thus raises the (out of equilibrium) demand for

firm i, raising firm i’s expected profit. Moreover, ∂E[πi1(.)]∂Ki

is greater in magnitude the larger

is ∂G∂Ki

. We can now follow an argument similar to that in Proposition 3 and evaluate (7) at

Ki = 0 to obtain the result. ¤

The proposition establishes that for ∂G∂Ki

large enough in absolute value, it will always be

the case that K∗i > 0 in equilibrium. In other words, when customers are sufficiently socially

conscious, firms adopt a governance policy that focuses more generally on stakeholders rather

than just shareholders. Moreover, the comparative statics result is that the more sensitive is

consumers’ demand to increases in firms’ commitment to weighting stakeholders, the more

will firms commit to providing this.

One conclusion that can be drawn from these cases is that stakeholder societies can be

self-reinforcing in a wide range of situations. The fact that social norms exist that lead

customers to prefer to do business with socially conscious firms makes firms want to be

socially conscious. Since every firm does this, there need be no change in aggregate demand

and sales, but there is an increase in prices and possibly in firms’ profits as well. Firms thus

compete with each other by setting up their organizational structures so as to in essence

cooperate more. A result of the social concern by consumers, however, is that there is a

transfer from consumers to the firms and the workers. An interesting side note is that since

output is reduced, the stakeholder society is also farther away from the efficiency of perfect

competition, and this happens independently of whether firms’ profits end up higher or lower.

20

5 Globalization and Firm Objectives

So far we have considered the case where firms operate in the same cultural or social en-

vironment and have analyzed the effects and the incentives for firms to adopt stakeholder

concerns. We now consider a setting where firms in their domestic market all operate in a

similar fashion, being all either purely shareholder oriented, or all having similar stakeholder

concerns, and they face the entry of an additional firm with possibly different objectives. We

have in mind a situation where a foreign firm enters into a new market where the goals of

the domestic firms may be different from those of the foreign entrant. In particular, this de-

scribes the case where a stakeholder oriented market, such as Japan, for instance, faces entry

of a U.S. style firm whose primary concern is to maximize shareholder value. Conversely, it

also captures situations where shareholder friendly markets face the entry of a firm whose

objectives are to generate value for stakeholders more generally.

Suppose that there are N symmetric firms with Ki = K ≥ 0 for i = 1, ..., N . These firms

can all therefore be either purely shareholder oriented, or stakeholder oriented to the extent

given by K. There is an N + 1 firm that enters, with KN+1 ≥ 0, so that the entrant firm

can also be either shareholder or stakeholder oriented.

Since the N incumbent firms are symmetric, we will restrict our analysis to equilibria

where these N firms all behave symmetrically, although the N+1 firm may behave differently.

Define pN = pi1, which is just the first period price set by a representative firm i = 1, ..., N .

We begin by characterizing the expected profits for firm i. For ease of notation, define πn2 as

the expected profit for (a representative) firm i when n firms are active at time 2. Trivially,

we have that πn2 > πn+1

2 for n ≤ N − 1. Absent the entrant, N + 1st firm, and focusing on

an equilibrium with symmetric prices, we can now write

Πi(N) = E[πi1]− (1− F (pi1 − c)) Ki

+F (pi1 − c)

[N−1∑j=0

(N − 1

j

)F (pN − c)j

(1− F (pN − c)

)N−1−jπj+1

2

],

21

where pi1 = pN in equilibrium given the symmetry assumption.

Proposition 5 pN is increasing in KN+1.

Proof: With the entry of firm N + 1, we can write firm i’s profit, Πi(N + 1), as

E[πi1]− (1− F (pi1 − c)) Ki

+F (pi1 − c)

(1− F (pN+1,1 − c))[∑N−1

j=0

(N−1

j

)F (pN − c)j

(1− F (pN − c)

)N−1−jπj+1

2

]

+F (pN+1,1 − c)[∑N−1

j=0

(N−1

j

)F (pN − c)j

(1− F (pN − c)

)N−1−jπj+2

2

]

.

Similarly, we can write the profit for the entrant, ΠN+1, as

E[πN+1,1]− (1− F (pN+1,1 − c)) KN+1

+F (pN+1,1 − c)

[N∑

j=0

(N

j

)F (pN − c)j

(1− F (pN − c)

)N−jπj+1

2

].

Note that the derivative of ΠN+1 with respect to pN+1,1 is

∂E[πN+1,1]

∂pN+1,1

+f(pN+1,1−c)

[N∑

j=0

(N

j

)F (pN − c)j

(1− F (pN − c)

)N−jπj+1

2

]+f(pN+1,1−c)KN+1.

Setting this equal to 0 characterizes the equilibrium price for firm N + 1, pN+1,1. Since the

last term, f(pN+1,1 − c)KN+1, is clearly positive, we have that pN+1,1 must be increasing in

KN+1. Since prices for all N +1 firms are strategic complements, pN must also be increasing

in KN+1. ¤

Proposition 6 First period expected profit for the incumbent firms, E[πi1], is increasing in

KN+1.

Proof: To show that E[πi1] is increasing in KN+1, simply note that each firm’s profit

increases when the price of all firms, pi1, i = 1, ..., N + 1, increases. But Proposition 5

establishes that pN , as well as pN+1,1, the price for the entrant firm, are all increasing in

KN+1. ¤

22

These two results together imply that, whether the incumbent firms are purely share-

holder oriented or if they care at all about other stakeholders, when an additional firm enters,

the resulting price will be higher the more stakeholder friendly is the entrant firm. Similarly,

the incumbent firms’ profits will be higher the more stakeholder friendly is the entrant firm.

Therefore, conditional on entry, incumbent firms prefer that more stakeholder oriented firms

enter. The flipside, of course, is that stakeholder oriented firms are most hurt by the entry

of a shareholder firm relative to having another stakeholder firm enter.

One implication of our findings is that firms with a focus on the maximization of only

shareholder value are likely to encounter greater resistance when entering a new market

than would firms that are more stakeholder friendly, since the entry of the former is more

detrimental to incumbent firms. This resistance may come either directly from the existing

firms, or from government policies geared toward protecting domestic firms from the threat

of foreign entry. Since the entry of a shareholder firm reduces the profitability of domestic

firms more than the entry of a stakeholder firm, shareholder firms may find it more difficult

to enter. Moreover, this resistance is likely to be greatest in countries where stakeholder

governance is the norm, since the firms in these countries are the ones most likely to be

affected by the entry of firms with only a shareholder focus.

Our framework can also be used to understand an additional important aspect of glob-

alization, which is the acquisition of a domestic firm by a foreign institution. For instance,

our analysis can be applied to situations where a firm that maximizes only shareholder value

buys another firm in a foreign market where firms that care about stakeholders more gen-

erally operate. After the acquisition, the newly purchased firm simply adopts the parent

company’s governance structure. Similarly, it can also be useful for studying situations in

which, in a given country or market, a firm tries to go against the current social and cultural

norms and operates only maximizing shareholder value.

To study this aspect of globalization, we now consider the case where both shareholder

and stakeholder firms operate together, but keep the number of firms constant - and equal

23

to two for simplicity - assuming only that one firm changes from one governance structure

to the other. Formally, assume that firm i is a stakeholder firm with Ki > 0, while firm j

maximizes only shareholder value (i.e., Kj = 0). We can now state the following.

Proposition 7 The stakeholder firm sets a higher price than the competing shareholder firm,

i.e., pi1 > pj1.

Proof: The first order conditions are identical to (5). Condition (2) implies that, since firm

i places more weight on surviving into the second period than firm j, in equilibrium it will

also set a higher price (for details, see Dixit, 1986). ¤

The result in Proposition 7 states that the stakeholder firm would charge a higher price

and, as a consequence, have a lower market share (i.e., lower quantity produced) than the

firm maximizing only shareholder value. From this, it follows that the stakeholder firm loses

market share to the shareholder firm who is solely concerned with maximizing shareholder

value and therefore is willing to offer a lower price.

We can say something further by comparing the solution above to the situation prior to

the acquisition, in which Kj > 0. For this, we have:

Proposition 8 Stakeholder firms set higher prices when competing with other stakeholder

firms than when competing with shareholder firms: pi1|Kj>0 > pi1|Kj=0.

Proof: See appendix. ¤

The intuition behind these last results hinges once again on the effect of the concern for

stakeholders on firms’ incentives in setting prices. Given that firms compete in strategic

complements, the stakeholder firm “follows” its rival in setting a price lower than when its

rival was a stakeholder firm. However, as stated in Proposition 7 above, the concern for

stakeholders prevents the stakeholder firm from reducing its price to the level charged by the

shareholder firm. Taken together, these results imply that the acquisition of a stakeholder

24

firm by a shareholder firm leads to lower overall prices. While this is likely as well to lead

to greater output, the domestic stakeholder firm clearly loses market share to the foreign

acquirer.

6 Robustness

In this section we consider two checks on the robustness of our results. The first concerns

the way we model firms’ concern for stakeholders. The second considers the effect of having

quantity rather than price competition.

6.1 Alternative Concerns for Stakeholders

So far we have considered that firms take account of stakeholder concerns by choosing an

organizational structure where stakeholders’ interests are taken into account. Formally, we

have assumed that firms weight the loss that stakeholders other than shareholders suffer in

case their firms go bankrupt. We now consider another possible way of modelling stakehold-

ers’ interests, as was briefly mentioned in Section 3. Specifically, we consider that employees,

suppliers and other stakeholders receive rents from the relationship with the firm. We model

the firm’s concern for these stakeholders by adding the term F (pi1 − c)ki to its profit when

it stays solvent. With this modification firm i’s objective becomes

maxpi1

Ωi = Πi(ki) + F (pi1 − c)ki

= E[πi1] + F (pi1 − c)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)+ F (pi1 − c)ki. (8)

It is straightforward to see that this alternative way of modeling stakeholders’ does not affect

firm i’s pricing. As in the basic model, the concern for stakeholders leads firms to increase

prices relative to those in the two-period model and to the same level as in Proposition 2.

Similarly for the other propositions.

25

6.2 Model of Quantity Competition

Consider a variant of the model above where firms compete by choosing the quantity they

want to produce instead of the price at which to sell. Specifically, firm i’s demand function

in period t is given by

Pit = A− biiqit − bijqjt

Expected profits in period t are then given by

πit = (Pit − ci) qit = (A− biiqit − bijqjt − ci) qit

With two periods, we assume that each firm is subject to a shock to its marginal cost in

period 1: ci = c+ εi. Note that πi1 ≥ 0 ⇔ εi ≤ Pi1− c, so that the probability this condition

is satisfied is just Pr (εi ≤ Pi1 − c) = F (Pi1 − c).

The objective for firm i is now to maximize Πi− (1− F (Pi1 − c)) Ki with respect to qi1:

maxqi1

E[πi1] + F (Pi1 − c)((1− F (Pj1 − c)) πM

2 + F (Pj1 − c)πD2

)− (1− F (Pi1 − c)) Ki

The FOC is given by

∂E[πi1]

∂qi1

+ f(Pi1 − c)∂Pi1

∂qi1

(Ki + (1− F (Pj1 − c)) πM

2 + F (Pj1 − c)πD2

)= 0

Note that, for the second term, ∂Pi1

∂qi1< 0, but that all other terms are positive, implying

that the entire second term is negative. Moreover, the absolute value of this expression is

increasing in Ki, so that the equilibrium first period quantity choice, qi1, will be decreasing

in Ki. As a result, the first period price, Pi1, will be increasing in Ki, thus confirming this

result from the model of price competition.

We next extend the model to allow firms to choose Ki in similar fashion to Section 3.

Assume that at time t = 0 each firm chooses Ki. Then, conditional on each firm’s choice

26

of Ki, at time t = 1 each firm chooses how much to produce in the first period. Solving

by backward induction, firm i’s optimal quantity choice at t = 1, for given Ki and Kj, is

qi1 (Ki, Kj). At t = 0, each firm then maximizes its overall profits with respect to Ki:

maxKi

Πi = E[πi1(qi1, qj1)] + F(Pi1 − c

)((1− F

(Pj1 − c

))πM

2 + F (Pj1 − c)πD2

)

where Πi = Πi(qi1, qj1), and Pi1 = Pi1(qi1, qj1). We focus again on the symmetric case where

bii = bjj and bij = bji, and on the symmetric equilibrium in the choice of Ki.

The derivative of expected profits with respect to Ki is given by

∂Πi

∂Ki

=∂E[πi1(qi1, qj1)]

∂qj1

∂qj1

∂Ki

+ f(Pi1 − c

) ∂Pi1

∂qj1

∂qj1

∂Ki

((1− F

(Pj1 − c

))πM

2 + F (Pj1 − c)πD2

)

+F(Pi1 − c

) (πD

2 − πM2

)f(Pj1 − c)

∂Pj1

∂qj1

∂qj1

∂Ki

− f(Pi1 − c)Ki∂Pi1

∂qi1

∂qi1

∂Ki

.

The term∂bqj1

∂Kican be written as

∂bqj1

∂Ki=

∂bqj1

∂qi1

∂bqi1

∂Ki> 0 since

∂bqj1

∂qi1< 0 (strategic substitutes) and

∂bqi1

∂Ki< 0 from the discussion above. Since ∂E[πi1(.)]

∂qj1< 0, the first term is strictly negative. For

the rest, note that ∂ bPi1

∂qj1,

∂ bPj1

∂qj1< 0 since a greater quantity by either firm reduces the price

each firm obtains. Since∂bqj1

∂Ki> 0, this implies that all remaining terms are also negative,

so that ∂bΠi

∂Ki< 0 for all Ki > 0. We have therefore established that when firms compete

in their choice of quantities to produce, no firm would voluntarily choose a positive Ki in

equilibrium, despite the fact that doing so would raise both firms’ profits.

As a final point, we analyze the case where a social norm exists that induces firms

to become more stakeholder-oriented. We incorporate this by assuming, as above, that

bii = G(Ki, Kj), with ∂G∂Ki

< 0 and ∂G∂Kj

> 0, and that G(Ki, Kj) = G for Ki = Kj. It is

straightforward to show that, as for the case where firms compete in prices, the more respon-

sive are customers to firms’ concerns for their employees, the bigger will be the incentive for

firms to take into account stakeholders. Therefore, for ∂G∂Ki

sufficiently large, ∂bΠi

∂Ki

∣∣∣Ki=0

> 0,

and choosing a positive Ki will be optimal, thus confirming the results from Section 4.2.

27

7 Concluding Remarks

Most of the literature on corporate governance is concerned with ensuring that the firm is

operated in the interests of shareholders. However, in many countries firms are not only

concerned with shareholders but also other stakeholders such as employees and suppliers.

In this paper we have developed a model of stakeholder capitalism and have shown that

both firms and stakeholders can be made better off if firms adopt a concern for stakeholders.

However, one result of this change is that prices can be higher so consumers may be worse

off.

In a country such as Germany, concern for employees is embedded into the structure of

corporations through codetermination. This mandates worker representation on the super-

visory boards of large corporations. Even when such concern is not mandated by law, we

show that there exist circumstances where firms will voluntarily want to embed concern for

stakeholders in their organizational structures since this increases their value compared to

just focusing on shareholders. One way of doing this is to give managers some latitude since

as employees of the firm their basic incentives are somewhat aligned with the workers and

other stakeholders. Even in other circumstances where firm value is not directly increased

in this way, firms may voluntarily adopt concern for stakeholders if consumers prefer to do

business with such firms. Consistent with our model, there is recent evidence that employee

representation on supervisory boards increases firm efficiency and market value (Fauver and

Fuerst, 2006). An open question, however, is whether the pricing policies of firms differ

systematically as a function of their governance structure, as predicted here, or whether the

higher value accruing to firms with employee representation stems from other sources.

An important issue in the context of globalization concerns the effect of entry by stakeholder-

oriented firms into shareholder-oriented societies and vice-versa. We show that all incumbent

firms whether they are stakeholder- or shareholder-oriented prefer a stakeholder firm to en-

ter rather than a shareholder firm. This raises a clear political economy perspective on firm

governance, in that countries that are focused on a broader set of stakeholders are more

28

likely to resist the entry of shareholder-oriented firms. This resistance can be either through

direct opposition by incumbent firms, or through government policies aimed at protecting

domestic firms. Studying the broader implications of this perspective is an interesting avenue

for future research.

The model we have used for the product market is clearly a very simple one. Many other

features could be added. The point of using a simple model was to illustrate that concern

for stakeholders can lead shareholders to be better off. In fact they may voluntarily choose

to adopt a concern for stakeholders. These results should hold in more general models of the

product market.

We have treated shareholders, stakeholders, and consumers as different groups. In prac-

tice, of course, there is a large overlap between them. For example, workers are also con-

sumers. One issue is whether concern for stakeholders can be welfare improving compared

to firms focusing on shareholders alone. Given that there are deadweight costs and rents this

is a possibility. If so, how broad are these circumstances? We leave these important issues

for future research.

29

A Omitted Proofs

Proof of Corollary 1: Recall the FOC for profit maximization, equation (3):

∂Πi

∂pi1

=∂E[πi1]

∂pi1

+ f(pi1 − c)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)= 0.

Denote p′i1 = pi1(σ′i) as the value of the first period price that satisfies this expression

with equality for a given variance σ′i, and note that trivially p′i1 > c. Since the second

term, f(p′i1 − c)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

), is strictly positive whenever f(p′i1 −

c) > 0, this implies that, at equilibrium, ∂E[πi1]∂pi1

< 0. Fix p′i1 > c, and let the variance

σi → 0. We have that limσi→0 f(p′i1 − c) = 0. Therefore, there is always a value σi such

that, for any σ1i < σi ≤ σ2

i , f(p′i1 − c|σ1i )

((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)< f(p′i1 −

c|σ2i )

((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

).

Consider now a value of the shock variance σi < σi. Given the fixed value p′i1,

∂Πi

∂pi1

∣∣∣∣pi1=p′i1

=∂E[πi1]

∂pi1

∣∣∣∣pi1=p′i1

+ f(p′i1 − c|σi)((1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)< 0.

To restore equilibrium, the first period price pi1 must fall. To see this note that since

∂2E[πi1]/∂2pi1 < 0, a fall in pi1 increases ∂E[πi1]/∂pi1 (makes it less negative). Also since

the density function of εi is non-increasing in the absolute value of εi and p′i1 − c > 0, a

reduction in p′i1 would increase f(p′i1 − c). Thus, for σi < σi, the equilibrium price pi1(σi)

falls as σi decreases and converges to the single-period equilibrium price pi as σi → 0. This

establishes that there must exist some threshold σi such that pi1 < pMi for σi < σi. ¤

Proof of Corollary 2: As Ki → 0, Proposition 1 establishes that the equilibrium first

period price, pi1(Ki), remains higher than the single period equilibrium price, pi. Moreover,

given our maintained assumption that σi < σi, Corollary 1 establishes that, as Ki → 0,

pi1(K) is lower than the joint profit maximization price pMi , and is increasing in Ki. From

the first order condition (5) for profit maximization, however, it is also clear that, as Ki →∞,

30

the equilibrium price pi1(Ki) rises until demand for firm i converges to 0, so that E[πi1] → 0.

Therefore, there must be some Ki such that E[πi1] is higher for Ki < Ki and lower for

Ki > Ki. ¤

Proof of Proposition 8: The two first order conditions for the stakeholder firm i and the

shareholder firm j are

∂E[πi1]

∂pi1

+ f(pi1 − c)(Ki + (1− F (pj1 − c)) πM

2 + F (pj1 − c)πD2

)= 0 (9)

and

∂E[πj1]

∂pj1

+ f(pj1 − c)((1− F (pi1 − c)) πM

2 + F (pi1 − c)πD2

)= 0. (10)

Note first that the first order condition in equation (9) implies a higher price than that in

(10) due to the term f(pi1 − c)Ki. More generally, we observe that

∂2Πi

∂Ki∂pi1

=∂2E[πi1]

∂Ki∂pi1

+ f(pi1 − c) > 0.

Coupled with the assumption that prices are strategic complements, we can apply the re-

sults from Milgrom and Roberts (1990, 1994) to show that prices must be higher when

the stakeholder firm competes with another stakeholder firm than when it competes with a

shareholder firm, so that pi1|Kj>0 > pi1|Kj=0, as in the proposition. ¤

31

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33

and the West,” Long Range Planning 28, 33-44.

34

All stakeholders.

The Shareholders.

Figure 1: Whose Company Is It?

71

76

22

17

3

29

24

78

83

97

United

Kingdom

United States

France

Germany

Japan

Number of firms surveyed: Japan, 68; United States, 82; United Kingdom, 78; Germany, 100; France, 50.

Source: Masaru Yoshimori, “Whose Company Is It? The Concept of the Corporation in Japan and the West.” Long

Range Planning, Vol. 28, No. 4, pp. 33-44, 1995

35

Figure 2: Job Security or

Dividends?

89

89

40

41

3

11

11

60

59

97

United

Kingdom

United

States

France

Germany

Japan

Job Security

is more important

Dividends more important.

Number of firms surveyed: Japan, 68; United States, 83; United Kingdom, 75; Germany, 105; France 68

Source: Masaru Yoshimori, “Whose Company Is It? The Concept of the Corporation in Japan and the West.” Long

Range Planning, Vol. 28, No. 4, pp. 33-44, 1995

36